A Tax to Kill High Frequency Trading

The United States should adopt a financial transactions tax (FTT) to kill high frequency trading (HFT) by removing the juice from this pernicious practice. A tax would be a simpler, more direct approach than entrusting the SEC to make effective rules.

Before discussing HFT, let’s look at what a FTT is and the other good reasons for enacting this type of tax.

A FTT is a tiny tax, usually only a few basis points, levied on transactions in financial assets, and generally collected by a clearinghouse. The base of a FTT is the transactional amount. It could be consideration, strike price, or option premium. FTT is usually levied on sales of securities, but can also be imposed on unfilled orders, derivatives, repos, currency trades and any financial transaction.

Ironically, many jurisdictions with loose securities regulation—the United Kingdom, Hong Kong, and Singapore, for example—already have some form of FTT. Even the United States has a securities transfer tax to fund the SEC.

Sen. Tom Harkin, D-Iowa, and Rep. Peter A. DeFazio, D-N.J., have introduced a FTT bill, S. 1787. The European Commission has proposed a draft directive for a FTT for the European Union; 11 EU member countries have agreed to adopt it. The American legislators just want to pick up revenue, while the Europeans aim to affect behavior.

Revenue. The revenue estimates attached to FTT proposals are very large, but they are not the best reason to favor a FTT.

The FTT acts like a cigarette tax. It would pick up some revenue while discouraging dangerous activity. Indeed, a FTT should be considered a failure if the taxed activity continued at 2008 levels (on which some revenue estimates are based).

A FTT would be a good way to recoup some of the continuing $13 trillion cost of the U.S. bank bailouts while discouraging the proprietary trading that regulated banks should not be doing anyway.

The Harkin-DeFazio bill calls for a FTT of three basis points (hundredths of a percent)--much lower than the proposed EU minimum rate. Nonetheless, the bill would raise $350 billion in 10 years, according to the Joint Committee on Taxation. That number appears to assume that it would be business as usual for Wall Street.

The European proposal assumed that a proposed FTT would apply across the EU and that it would reduce the taxed activity. The revenue estimate was €19 billion annually from securities transactions (at a rate of 10 basis points) and €38 billion from derivatives (1 basis point on notional value). Some 70 percent of the revenue would come from London.

Ease of collection. FTT is shockingly easy to collect, which is important when Congress deliberately underfunds the IRS and tax administration is suffering.

A FTT is collected in real time. Tax is remitted as the transactions happen and money is transferred. The financial sector’s recordkeeping makes a FTT very easy to administer. A clearinghouse maintains a trade reporting system that forms an audit trail for the tax collectors. Moreover, exchanges and clearinghouses are regulated, so the government can demand that they collect tax.